An Interesting Study Of Neighboring Counties Shows The Downside Of Extended Unemployment Benefits

REUTERS/Lucas JacksonIt's been four years since the Great Recession ended, but the US' jobs reports continue to disappoint.

A group of economists, including Marcus Hagedorn from the Institute for Advanced Studies in Austria, Iourii Manovskii, a professor at UPenn, Kurt Mitman, a PhD student and Fatih Karahan from the New York Fed believe that the increase in unemployment benefits during the recession are the cause.

From their NBER paper entitled "Unemployment Benefits And Unemployment In The Great Recession- The Role of Macro Effects":

"The logic of the model is simple. Everything else equal, extending unemployment benefits exerts an upward pressure on the equilibrium wage. This lowers the profits employers receive from filled jobs, leading to a decline in vacancy creation. Lower vacancies imply a lower job finding rate for workers, which leads to an increase in unemployment."

Their argument may not be new, but their research methodology is. The paper compares counties that neighbor each other but are in different states. The argument behind this that these areas are "expected to have similar labor markets due to the same geography, climate, access to transportation, agglomeration benefits, access to specialized labor and supplies, etc." The only difference between them being the difference in unemployment policies across their two states.

They found that states that extended unemployment benefits experienced a drop in employment. Quantifiably, this means that a 1% rise in benefit duration for one quarter increases the unemployment rate exponentially, by e0.06, or 1.06%. Over the long run, this effect strengthens. If benefits are extended from 26 to 99 weeks, the long run average unemployment rate rises from 5% to 10.5%.

From the paper:

"Our estimates imply that most of the persistent increase in unemployment during the Great Recession can be accounted for by the unprecedented extensions of unemployment benefit eligibility. In contrast to the existing recent literature that mainly focused on estimating the effects of benefit duration on job search and acceptance strategies of the unemployed - the micro effect - we focus on measuring the general equilibrium macro effect that operates primarily through the response of job creation to unemployment benefit extensions. We find that it is the latter effect that is very important quantitatively."

Their findings are in contrast to a similar study by Yale economists that a rise in minimum wages in one district found a relative increase in employment compared to its neighbors that did not have a minimum wage increase. The Yale study, however, uses data from Indonesia in the 1990's, which experienced a geographically varied change in minimum wages. Higher wages push local demand up, which gives local employment a push.